What do closers need to know about the replacement property closing statement and what closing costs are permitted on that statement?
Remember the Big Picture
Remember, our big picture here is that we're trying to reinvest all of the exchanger’s equity into the property. So if there's going to be a mortgage or deed of trust on the replacement property we may have to constrain the lender to tell them "don't loan this buyer more money than they actually need to make this purchase happen."
Even though the exchanger may qualify for a larger loan, we need to rein that lender in and not let them over-loan the purchase of this property such that at the bottom of the closing statement it shows cash to the buyer in the amount of x. We want that closing statement to zero-out at the bottom so that our buyer won't get any cash back at the time of closing.
Transactional Expenses
The next item to remember is that certain transactional expenses should not be paid for out of the exchange funds. In particular, any costs related to that new mortgage or deed of trust should typically be paid for by the exchanger out-of-pocket. Alternatively, the exchanger may ask the lender to give them a no-cost loan such that there are no origination fees or charges for the loan but that the exchanger pays a higher interest rate in return for the no cost loan.
Another technique that taxpayers sometimes use is to ask the seller for a concession to say “seller, will you pay up to $5,000 of my closing cost and prepaid expenses at the time of closing?” That way they're able to move some of these non-qualified transactions onto the seller side.
If there will be any reserve accounts established (for example to pay property taxes or insurance premiums), those reserves should be funded with monies other than the 1031 funds, so that all of the 1031 funds are applied exclusively for the purchase of the like-kind replacement property. A reserve account full for cash may be deemed ‘boot’ by the IRS, so oftentimes buyers will fund the reserves out-of-pocket.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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